Iceland in showdown with bondholders

Iceland will this week tell hedge funds and other creditors in its failed banks how their claims can be settled. 

The government has designed a model to protect the krona from any jolts that might result from a capital outflow as currency controls are relaxed to enable repayment. The next step is to find out whether the creditors will accept the deal.

“Creditors that are unfairly treated internationally do not just walk away,” Timothy Coleman, senior managing director of Blackstone Group, which is advising bondholders in Kaupthing Bank, said.

“They will use every part of every legal system available to them to ensure that they are treated appropriately and fairly.”

As Iceland starts to scale back currency restrictions in place since 2008, the central bank has suggested the process may involve an exit tax. While Coleman emphasised that creditors have no interest in a deal that undermines Iceland’s financial stability, he made clear there are some pills bondholders won’t swallow. “I don’t think they are assuming an exit tax,” he said.

Creditors in Kaupthing, once Iceland’s biggest bank, say they are owed €18.7bn, according to the bank’s first-half report. That’s more than three times as much as the bank has in reported assets.

“The debt against Kaupthing is trading below 30c on the dollar, so” creditors “understand there will be some negotiated cost”, Coleman said.

Bondholders have three demands, he said: “The creditors want to secure a solution that respects the people of Iceland and their capital controls. That would be number one,” he said.

“Number two would be to be paid back the money that they lent to the Icelandic banks. And, number three, the creditors have an expectation that they will be treated in accordance with international banking standards.”

Creditors that have bought claims against Iceland’s failed banks include hedge funds Davidson Kempner Capital Management and Taconic Capital Advisers. The finance ministry in Reykjavik set the process for settlement in motion last week, when it granted an exemption from capital controls to LBI — a unit that represents creditors in failed Landsbanki Islands — allowing it to repay 400bn kronur (€2.6bn) to priority claimants.

A full proposal for unwinding the capital controls, which are blocking almost €5.7bn from exiting the €12bn economy, will be presented this week.

The process marks a final milestone in Iceland’s road to recovery from the €70bn banking default that forced it to seek an international bailout six years ago.

Iceland, which avoided a government default by leaving bank bondholders in the lurch in 2008, hired a team of advisers earlier this year to help it work through its options in dealing with the creditors.